Sum7 Credit Analysis

Corporate Banking - Credit Analysis
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Introduction to Credit Risk Management
Credit Team Structure
Banks usually have an independent credit team and a separate risk team (which finally approves
the credit proposal).
The credit team can also be split across–
Front office - RM and credit department
Mid office - Risk Department
Back office - credit post-sanction documentation team
Preparing a ‘Credit Note’, is the key responsibility of the credit department. The credit appraisal
involve evaluating the borrower on –
1. Ability to Repay and
2. Willingness to Repay
Credit Appraisal – Large Corporates vs. Mid Corporates & SMEs
Parameters Large Corporates Mid Corporates and SMEs

Due diligence required for appraisal Lower Much higher
Consideration of adverse observations Accommodative Non-accommodative
(particularly subjective factors)
Unsecured WC limits sanctioned from banks Generally accepted May not be acceptable
Ratings
Rating is, essentially, attaching an alphabetical/alphanumeric symbol to the credit worthiness of
the company (its ability to repay debt). Typically, this rating scale differs across different
agencies, different instruments and tenors.
Types of Ratings
i. Issuer Rating - Given to companies on the strength of their financials.
ii. Issue Rating - Given to a particular debt issue (bonds, long term loans, short term loans,
etc.)
Ratings Watch
1. Positive watch - A positive would mean that the rating agency believes that, the rating given
to the corporate is likely to improve by the next review.
2. Negative watch - A negative watch would mean that the rating agency believes that, the
rating given to the corporate is likely to deteriorate by the next review.
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The Basic Credit Risk Model

The Basic Credit Risk Model shows the risks at different levels that have to be evaluated, before
assigning a risk score. It includes –
1. Economy risk
2. Industry Risk
3. Company Risk
Economy Risk
Economic Cycles
Economic cycles/business cycle refer to the ‘rise and fall’ of economic health that most
economies go through, every few years. This is the economy-wide fluctuations in production or
economic activity, over several months or years.
Economic cycles are not a part of credit analysis on an ongoing basis. In an economic
downturn, risk scores and ratings tend to be negatively impacted as the uncertainties get
magnified.
Industry Risk
Different industries tend to have distinct set of characteristics. These could be cyclical or
delinked to the economic/business cycles (Example: food grains).
Cyclical – Cement, Steel, Construction etc. Due to the durable nature of the goods, purchases
often get postponed in poor economic conditions, but sales increase, as the economy picks up.
Non-Cyclical - Utilities, household non-durable goods, pharmaceuticals etc. No matter how the
economy is performing, these are the basic necessities; they are not subject to economic
fluctuations.
The main factors one should consider while doing an industry analysis are:
1. Industry Characteristics
i. Product range of the industry
ii. No. of players in the industry
iii. Demand Drivers for the industry
iv. Market Share of key players
v. Average operating margin of players
vi. Average net profit margin of players

vii. Key entry barriers
viii. Key concerns affecting the entire industry
2. Industry Outlook
A risk score is assigned to the company, on the basis of how positive/negative the industry
outlook is. Basic data that needs to be studied is:
Average industry capacity utilization
Demand & Supply situation in the future (1-5 years)
3. Government Policies & Stance on Sector – One should take a conservative approach
while projecting the financials of companies, when the company is impacted significantly by
government policies.
Porter’s Analysis
Porter’s analysis involves five environmental factors (‘forces’) that impact a company’s ability to
compete in an existing market. Porter’s five forces are as follows:
1. Entrants Barriers - The threat of potential new entrants may be economies of scale, product
differentiation etc.
2. Bargaining Power of Buyers - Buyers compete with the suppliers by negotiating down prices,
demanding higher quality etc.
3. Bargaining Power of Suppliers - Suppliers exert power in the industry by threatening to raise
prices or to reduce quality.
4. Industry Competitors - Rivalry among existing firms in the industry
5. Threat of Substitutes - Products with similar function limit the prices firms can charge.
Company Analysis
There are many subjective or non-quantitative factors that create default risk. These factors are
important to the process of credit evaluation and can make a big difference to the actual risk
score of the company.
1. Management Competency
The competency of the management of the company is one of the most important factors in
deciding how the company fares over the next few years.
Key Parameters :
o Professional Qualifications
o Experience of management
o Ownership
o Past Track Record
2. Promoter and Management Track Record

Reputation of promoter
Promoter Shareholding
3. Concentration Risk - Concentration Risk is the risk that arises from the company being too
dependent on either customers or suppliers; or, in some cases, on revenues from certain
geographies.
Types of Concentration Risk
Customer Concentration
Supplier Concentration
4. Operational Profile - In the operational profile, you will have to analyze:

The Basic Business Profile
Product Strength
Production Profile
Utilization and realization
Value chain strengths

There are two key strengths that one has to judge as a credit analyst
Customer relationships – Customer relationships that are strong and have been steady over
time, are intangible but important assets to any company. These need to be evaluated and
the company rated on its ability to form and consolidate customer relationships.
Backward integration - Any backward integration is considered a strength in the value chain
as the company is assured of support in times of need. Also, in many cases it reduces costs
and makes the company more competitive.
Cost structure and control

For any lender, the best borrower is one who is frugal in his use of money. This holds for any
corporate big or small, mature or new in the industry. The RM/credit analyst needs to look at
how the company has been controlling costs and what are the trends in this respect. Finally, a
rating has to be given to this aspect based on industry benchmarks and trends.
Group Profile
In case of large business groups, the consolidated position of that group becomes equally
important, and an overview of the same must be covered in the credit note.
A special note must be made of any: The business interests of the group, performance of the
other group companies, dealings (financial/ operational) between various group companies
must be looked into.
Peer Group Analysis

The final step in the qualitative exercise is a brief analysis, comparing operations and financials,
of key competitors of the company (having comparable business models).
Financial Analysis: Profit & Loss Statement
Income
Gross Sales(Manufacturing)
Net Sales(Trading)
Less: Excise Duty
Add: Other Operating Income (eg. Processing Charges)
Net Sales
To find the Net Sales, we need to find values for all the sub heads.
Gross Sales (Manufacturing): This refers to the sales that is generated through the
operations of the company. In this case the company is a manufacturing company. Gross sales
is the total of all sales done in the year without deducting any taxes or costs.
Excise Duty: It is a direct tax on value of produced goods and hence deducted from total sales
to arrive at the net sales amount. The company is just acting as a channel to collect this tax and
remit it to the Excise department.
Other Operating Income –

It refers to all that income that is expected to recur on an annual basis, and which is a
byproduct of the main manufacturing process. This could be sale of scrap, processing charges,
assembling charges for goods sold etc.
Net Sales (Trading): Often, even companies that are into manufacturing, get into trading of
goods, primarily to take advantage of any temporary shortage in the market. Some companies
also do it on an ongoing basis. This is considered more risky than manufacturing or operating
sales, as the opportunities to trade could dry up suddenly or be affected by some policy
decision.
Other Operating Income: Refers to all that income that is expected to recur on an annual
basis and are byproducts of the main manufacturing process. This could be sale of scrap,
processing charges, assembling charges for goods sold etc. It is taken as part of the operating
income of the company.
The classification under other operating income may vary from company to company, but we
will always consider it under the head of other income.
Net Sales
It is simply the gross sales plus other operating income, less excise duty and taxes.
Remember,
Net Sales = Gross Sales - Sales Tax - Excise Duty + Other Operating Income
This is used for calculations, in many ratios related to sales of the company.
Cost of Production
We now need to calculate the cost of Production, or ‘COP’. The cost of production takes into
account only those costs that are related to the production of goods, sold by the company.
Purchase of Other Finished Goods
Sometimes the manufacturing process requires purchase of certain finished goods. They are
used to make the final product produced by the company.
Raw material consumed – This refers to the value of the total raw material consumed to
make the goods that were sold. The raw materials include both raw materials and stores (other
than primary raw materials). The raw material consumed in a period is = Opening Stock for the
period + Purchases – Closing Stock for the period.
Power Costs – Value of any direct power used to produce the goods. This has to be added to
the cost of goods sold.
Any other direct costs - Any other costs that can be associated with the production of goods.
These costs are directly proportional, like other direct costs, on how much the company
produces. They will not be incurred if the company stops production.
Depreciation & Amortization:
Depreciation represents the wear and tear on the machinery and other physical/tangible
assets that are used by the company.
Amortisation is reduction in value for intangible assets.
To account only for costs associated with goods that have been produced this year, the
increase (i.e. closing stock > opening stock) or decrease (i.e. closing stock < opening stock) in
the amount of goods has to be tracked.
Hence, the formula for Cost of Production is:

Purchase of finished goods + Raw material consumed + Power costs + Any other direct costs +
Depreciation & amortisation + Opening stock in process – Closing stock in process
Cost of Sales (COS)

The increase or decrease in the amount of finished goods has to be tracked.
The formula for cost of sales is:
Opening stock of finished goods + Cost of production – Closing stock of finished goods
PBDIT
Stands for Profits before Interest, Taxation, and Depreciation & Amortization - This is one of the
most important figures in the income statement. To a bank or a lender, this represents the
profit that is made available through the operations of the company.
PBIT
‘PBIT’ refers to Profit Before Interest and Taxes. This number represents the earnings or profit,
after considering depreciation & amortisation, and before deducting interest costs and taxes.
1. Employees’ Remuneration – This includes all costs that have been incurred on
employees. It will include employee wages, salaries, contribution to PF and other welfare
costs.
The cost is regarded as an operating expense and is semi variable in nature.
2. Operational Lease Payments – is the cost incurred on any machinery/equipment leased

for the purpose of production. This is added to operating expenses.
Most of the companies put operational lease payment under ‘Other expenses’. But for an
airline like Spice Jet, aircraft lease rental will be an operating expense.
3. Other Costs – Here, we look at any other costs that are direct and recurring in nature and
will vary with scale of operations. These are other than the direct expenses incurred on
operations.
An easier way to calculate this will be, to deduct expenses that we have already considered
under other heads, from ‘Other Expenses’.
4. Operational Provisions – would include any provisions that have been made for losses
within production or operations. This could be provision for repairs and maintenance of
plant and machinery.
Operating Profit before Tax

Operating profit before tax is derived from operating income minus operating expenses. Here,
operating income means net sales.
Whereas, operating expenses include cost of sales, administration expenses & interest expenses.
Hence, the formula for operating profit before tax in a period is:
PBIT (i.e. Net Sales – Total Operating Expenses) – Interest expenses
Interest Expense
Interest expense refers to interest paid by company on loan taken/debentures issued.

Interest paid includes all other charges or fees the company incurs in raising debt.
PBT Before Exceptional Items

PBT before exceptional items represents the Earnings, or Profits, after all obligations have been
paid off, except for exceptional income and expenses.
Non-Operating or other Income

Items not directly linked to operations should ideally be included in other income. This refers
to any income of the company that does not accrue from operations.
Non-Operating Expenses
Expenses incurred by activities which are not related to the core or central operations of the
business.
Profit Before Tax (PBT)
Lenders do not consider Exceptional or Extraordinary Items, as they are:

 One-off in nature
 Not expected to recur.
Example for Extra-ordinary Income: Cash

Sale of a subsidiary company:
The sale of a subsidiary company or a business line; the sale of a plant, or any other such income, that is
exceptional and one time in nature
Example for Extra-ordinary Income: Non Cash

One Time Settlement:
Example for Extra-ordinary Expense: Cash

Acquiring a company, buy a copyright, penalty on tender etc.
Example for Extra-ordinary Expense: Non Cash

Write-off of assets:
Profit After Tax (PAT)
After deducting tax, we arrive at the final measure of profit. PAT is also known as PAT (Profit
After Tax).
Taxes can be of three types – Current, Deferred & MAT .
Financial Analysis: Balance Sheet
Current Liabilities
Current Liabilities are liabilities that need to be repaid immediately, or within a year. Current
liabilities could be classified as:
1. Creditors for Purchases - These are the creditors for purchase of raw materials.
2. Other Current Liabilities – It includes -

Creditors for Expenses
Provision for Tax
Long Term Debt due within one year
Any outstanding expenses
Creditors on Capital Account - These are creditors for purchase of machinery or any
capital equipment, where the payment has to be made within 1 year.
Any other provisions or liabilities that are regarded as current by the credit manager
would be included in this.
Long Term Liabilities - Liabilities which are due for repayment, after one year. It includes:
Term Loan from institutions/Banks
Preference Shares due for Redemption in the next financial year
Fixed Deposits - Refers to any fixed deposits that the company issues to the public.
Foreign Currency Loans - Those raised through pre shipment/post shipment finance
(longer than a year) or ECBs.
Debentures
Long Term Liability to be taken as Quasi Equity - Any loan/ICD given to the company by
a parent company or associate company, is regarded as a quasi equity, as it is long term
in nature but not equity.
Capital and Surplus

1. Paid-up Capital - The amount of equity that has been invested by owners of the
company.
2. Preference Share Capital - Any preference capital that is not redeemable in the next
financial year.
3. Reserves and Surplus - Accumulated in the company over time. This gets
accumulated through share premium received, undistributed profits, and other general
reserves.
4. Revaluation Reserves - Any surplus amount that has been included in the balance
sheet through revaluation of fixed assets.
5. Loss Brought Forward - Any cumulative losses that are brought forward from
previous years.
Minority Interest – It refers to the shareholding of external shareholders in a company’s

subsidiary.
Deferred Tax Liability - Any tax liabilities pertaining to the previous years
Current Assets
Current assets are short term in nature. Their value changes due to the increase/decrease in
activity within the company. They reflect immediate liquidity within the company.
Current Assets include -
1. Inventories - It refers to the stock of raw materials (RM), finished goods (FG), spares and
work in progress (WIP) within the company. Inventory is an important section to analyze,
as any build up in inventory reflects either:
The inability of the company to sell, or
Inefficiency in the planning process.
Inventory can be further broken into –

Raw materials
Stock in-progress
Finished goods
Consumable spares
This break-up is needed to calculate the amount of time taken to convert raw materials into
finished goods (i.e. holding days for raw materials).
2. Trade Debtors - Trade debtors are those debtors who owe money to the company,
due from the sale of finished goods produced by the latter.
Trade debtors are further classified from a credit perspective into:

Debtors less than six months
Debtors over six months
If the debtors over six months have increased as a percentage of debtors less than six
months, then it’s a cause of concern for the lender.
3. Other Current Assets - It includes:

Cash and bank balance
Prepaid expenses
Loans and advances
Advance tax
Others (Deposits with sales tax etc.)
Fixed Assets are held by the company, to generate revenues - they are not for sale in the
regular course of business.
Gross fixed assets include:
Land & Building
Plant & Machinery
Capital Work in Progress - any WIP in respect of plant or capital equipment.
Sundries – any investment in fixed assets other than Land & Building and Plant &
Machinery.
Note: Depreciation to date is deducted from gross fixed assets to arrive at the net value.
Non Current Assets

These are assets that have a tenor longer than 1 year, but cannot be classified into the fixed
assets category. These include loans and advances greater than a year, deposits which are long
term in nature, etc.
Deferred Tax Asset

This refers to taxes paid in advance, that can be set-off with tax liability in the later years.
Intangible Assets/Miscellaneous Expenditure

Intangible assets are assets that do not exist in physical form. E.g. Patents, copyright, goodwill
etc.
Miscellaneous expenditure is, expenses incurred at the time of a public issue or any other equity
issue. These are capitalized over a long period of time as they do not pertain to any particular
year.
Short Term Loans

There are four primary ways the company can borrow in the short term.
Working capital loans - include CC and WCDL
Short term loans - taken for cash flow mismatches
Short term loans in foreign currency
Commercial Papers
Reclassified Balance Sheet

Liabilities Assets
Total Current Liabilities (a) Total Fixed Assets (e)
Total Long Term Liabilities (b) Total Current Assets (f)
Capital & Reserves (c) Other Non Current Assets (g)

Deferred Tax Liability (d) Deferred Tax Asset (h)
Intangible Assets/Miscellaneous Expenditure (i)
Total Liabilities (a+b+c+d) Total Assets (e+f+g+h+i)
Ratio Analysis
The ratios can be classified broadly into the following three categories:
Profitability Ratios
Leverage Ratios
Liquidity Ratios
Profitability Ratios
PBDIT Margin - PBDIT/Operating income.

PBDIT margin is the most important and popular ratio in the industry. It represents the
operating profitability of the company.
PBIT/Total Income - It reflects the profitability after taking into account all the expenses,
except financial costs (interest) and taxes.
Net Margin or PAT Margin - Profit after Tax (EAT) or PAT /Total Income
It shows the actual margin of the business after accounting for everything (all costs) including
any exceptional income/expense.
ROCE – PBIT/Average Capital Employed

The average capital employed is the average of current and previous years’ capital.
Capital employed includes -Total debt + Tangible net worth +any long term liability such as
preferred shares that can be treated as quasi-equity).
It shows the overall returns from the business, excluding interest costs. From a credit
perspective, this is an important ratio, as it displays the productivity and profitability of the
capital employed.
Return on Equity (ROE) - Earnings after tax/Capital and Reserves
This ratio gives the return, only on the equity base of the company. The ratio can be misleading
if the company takes debt (as long as it is priced lower than ROCE) and increases the ROE. The
credit analyst must check that.
Sales/GFA or Fixed Assets Turnover - This ratio shows the amount of revenue you are able
to generate by investing in Fixed Assets. This ratio is more relevant for companies that deploy a
high amount of fixed assets to generate income.
Basic Earning Power - PBIT/Total Assets

It shows how much profit is generated by investing in assets.
Leverage Ratios
Key terms -
Total Debt - Total Long term liabilities + Long term debt due within one year + Short
term borrowings. This is simply the total debt of the company including both short term
and long term.
Contingent Liabilities are off-balance sheet items. These items can turn into actual
liabilities; the lender needs to take this into account.
Tangible Net Worth - Capital and reserves + Deferred tax liability - deferred tax asset-
intangible assets - Revaluation reserve.
Total Debt/Tangible Net Worth - This is the most important leverage ratio for a bank. It
shows the use of total debt, on the base of the tangible net worth.
(Total Debt+ Contingent Liabilities)/Tangible Net Worth - This shows the leverage that
may occur, in case all the contingent liabilities materialise, and have to be borne by the
company.
Fixed Asset Cover Ratio - This ratio shows how many times the fixed assets cover debt.
Liquidity Ratios
Interest Coverage Ratio - (PAT+Interest Exp.+Depreciation)/Interest expense.

Interest coverage shows the amount available to pay interest as a multiple of the interest
expense.
(PAT+Interest Expenses)/Interest Expenses - This is similar to interest coverage, but

excludes depreciation.
Net Cash Accrual/Total Debt - The net cash accrual computes the amount of cash that
accrues to the company from its operations. This ratio is important, since it deals with the
actual cash flows. It is keenly noted by lenders.
Debt Service Coverage Ratio (DSCR) - (PAT + Interest Paid + Depreciation + Deferred tax
provision) / (Interest Paid + CPLTDpy)
CPLTDpy = Current portion of long-term debt (previous year)
DSCR is a critical ratio for the bank. It checks the repayments due, and finds out if the company
can generate enough cash, to be able to pay the obligations due.
Current Ratio - Total current assets/Total current liabilities

This reflects the liquidity position of the company. If there are sufficient current assets to
service the current liabilities, the company is unlikely to face a liquidity crunch.
Net Working Capital*/Net Sales - This gives you the amount of working capital required for
every rupee of sales.
*Net Working Capital = Total current assets - Total current liabilities
Raw Materials Holding (in days) – [(Closing balance Raw material + closing balance
Consumable spares)/Raw material consumed]*365
This shows how many days it takes from purchase of raw materials, to conversion into WIP.
WIP Holding (in days) – (Stock in process/Cost of goods sold)*365

It tells us the number of days it takes for the WIP, to be converted into finished goods.
FG Holding (in days) – (Finished goods/cost of goods sold)*365

This shows the holding days for Finished Goods, before they are sold.
Receivables Holding (in days) – (Total debtors/Total operating income)*365

This shows how many days of credit the company is giving for its trade receivables.
Credit Availment/Days Payable (in days) – [Creditors for purchases/(Purchases finished

goods +raw material consumed)] *365
This shows how many days of credit the company gets from its trade suppliers.
Operating Cycle in Days - RM holding + WIP holding + Receivables holding + FG holding -

Credit availment in days.
The operating cycle reflects the total number of days the company would need working capital
funding. The smaller the operating cycle, better it is for the company.
Working Capital Assessment

Banks finance WC requirements of a company, on the basis of operating or working capital
cycle, which is typically the credit period of a company’s receivables minus the credit period of
its payables.
Key terms
TCA (Total Current Assets) - Entire Current Assets excluding export receivables.
Other Current Liabilities (OCL) - Current Liabilities excluding Bank borrowings.
Working Capital Gap- TCA – OCL
Net Working Capital-That part of current assets that needs to be financed, through the
means of long term sources of funds.
Stipulated Net Working Capital (SNWC) - Minimum amount of NWC as stipulated for this
method by Tandon Committee.
Projected Net Working Capital (PNWC) - Minimum amount of NWC as per CMA data
provided by the company.
A standard way to compute the working capital requirements of a company is called the MPBF
method. This is followed by most banks.
MPBF stands for Maximum Permissible Bank Finance.
The Tandon Committee that was set up to look into the method for WC financing,
recommended two methods of computing MPBF- Method I and Method II. Method II of lending
is more commonly used.
Banks calculate MPBF on the basis of data provided to them by the company in a standardized
format -Credit Monitoring Arrangements(CMA).
Calculation of MPBF: Method I
Step 1: Calculation of WCG: TCA- OCL
Step 2: Calculation of SNWC: 25% of WCG
Step 3: Calculation of PNWC: TCA-TCL
Step 4: Calculation of MPBF: (a) WCG – SNWC (b) WCG – PNWC

MPBF=Minimum of (a) and (b)
Calculation of MPBF: Method II
Step 1: Calculation of WCG: TCA- OCL
Step 2: Calculation of SNWC: 25% of TCA
Step 3: Calculation of PNWC: TCA-TCL
Step 4: Calculation of MPBF: (a) WCG – SNWC (b) WCG – PNWC

MPBF=Minimum of (a) and (b)
MPBF: Method I vs. Method II

The only difference between the two methodologies is calculation of Minimum Net Working
Capital (NWC).
Method I Method II
Working Capital Gap TCA-OCL TCA-OCL

Stipulated Net Working 25% of WCG 25% of TCA
Capital (SNWC)
Projected Net Working TCA-TCL TCA-TCL
Capital (PNWC)
MPBF Minimum of WCG- SNWC Minimum of WCG-SNWC
&WCG-PNWC &WCG-PNWC
Note: It can be observed that minimum NWC would be lower in Method I.
Process followed by banks-

Step 1: Evaluation of CMA data provided by the company - The CMA data consists of 3 sections
in particular:
1. Income Statement
2. Balance Sheet-
Balance Sheet
Assets Liabilities NWC
3. Computation of MPBF - A credit note is then prepared with the necessary recommendations
of either approving or rejecting the proposal.
Product Structure: Key Concepts
Basic Terms
Tenor: Tenor is the period for which the borrower can enjoy the facility.
Rest: Rest is the period that the bank considers for deducting the amount of the principal
repaid, from the loan balance. It is relevant only for loans where interest is calculated on a
reducing balance.
Tranche: A tranche refers to an installment of the loan, that the bank disburses.
Sanction validity: The sanction validity refers to the period by which the client can avail
the facility.
Back to Back Facilities: Back to back facilities refer to a situation where one credit facility
automatically comes into existence, as soon as the other is dissolved.
NPA (Non Performing Assets): An NPA is a loan or an advance where, interest and/ or
installment of principal remain overdue for a period of more than 90 days.
Security
Security refers to any additional comfort that the bank can draw from the company, which
reduces its loss in case of a default. The different factors considered by a bank with respect to
security are:
1. Order of Importance for the Bank:

a) Primary Security: A primary security would usually be one that offers the highest
degree of comfort to the bank.
b) Collateral Security: Collateral security is usually additional security that the bank
takes, to even further mitigate the risk
2. Types of Security and Security Enforcement:

a) Tangible: Examples are land and building, machinery, stocks, book debts etc. The
different ways in which the bank’s rights over tangible security can be enforced are:
Mortgage: Referred whenever the asset is an immovable property. The owner
(borrower) retains the right of usage as well as title of the property.
Different types of Mortgage –
Equitable Mortgage
Mortgage by Memorandum of Entry
Registered Mortgage
Hypothecation: ‘Hypothecating’ an asset gives the owner the right to use it, and the
lender the right to seize and sell it in case of default. Example - all loans against
vehicles and equipment – even computers – are secured by hypothecating the assets.
Pledge: The borrower loses the right to use the asset.

Lien: ‘Lien’ refers to the right of the lender to retain any assets in its possession for the
purpose of security. Hence, in all the above cases, the bank has a lien on the asset.
b) Intangible Security:
Corporate Guarantees: Corporate guarantees are usually issued by a corporate to a
bank on behalf of another corporate.
Personal Guarantees: Guarantees issued by individuals in their personal capacity to
a financial institution, or to another beneficiary, are personal guarantees.
Top up Undertaking: The guarantor gives an undertaking to the bank totop up the
DSRA (Debt Service Reserve Account) to the requisite levels, in case the borrower
company defaults.
3. Security Coverage
a) Fully secured: The value of the security is equal to, or more than, the value of
facility offered to the borrower.
b) Unsecured: The value of the security is less than 10% of the facility amount.
c) Partially secured: The value of the security is equal to, or more than, 10% of the
facility amount but less than 100% of the facility amount.
Liquidity: Banks always prefer liquid assets (cash, stocks etc.) as security, as theyare easily
saleable.
Enforceability of Charge: The right of the bank, to either sell or appoint a receiver for the
collateral in its possession.
Types of charge
Exclusive charge over the security – The borrower cannot use the asset as a security for
any other facility.
Pari Passu charge – The lender is on an equal footing with other lenders who have a claim
on the security, but in proportion to the amount lent.
Encumbrance of Security:
a) Encumbered: The borrower does not have a clear title to the property (i.e. used as a
security).
b) Unencumbered: The borrower has a clear title to the property (i.e. used as a security).
Covenants and Structures

These are conditions that are laid down by the bank and have to be followed by the client for
availing the facility. Covenants can be of two types:
1. Affirmative Covenants: These covenants require the company to do something.
2. Negative Covenants: These covenants require the company to abstain from doing
something and are restrictive in nature.
Credit Note
Credit Note: The Credit Note or Credit Appraisal Memorandum or CAM as most bankers in
India call it, is a note which seeks to objectively evaluate a company on its credit worthiness.
The main features of a credit note are:
Is used to keep track of the various terms and conditions.
Includes the justification for sanctioning the facility.
Is the single most comprehensive document that has the important details about the
relationship of the bank with a corporate.
Is usually signed by the senior management of the bank (for example; credit head of that
division).
Basic process flow for credit from inception to disbursement involves the following steps:
1. Requirement analysis by Relationship Manager
2. Product advisory by Production Manager
3. Indicative term sheet preparation
4. Circulation of In-Principle Approval
5. Preparation of credit note (CAM)
6. Review of CAM
7. Presentation and Sign Off
8. Filing of CAM
9. Issue of facility letter
10. Documentation
11. Limit Setup
12. Disbursement of funds
13. Monitoring
A credit note has the following components:

1. Sign off page
2. Executive Summary
3. Facility Description
4. Borrower Profile
Business Profile
Financial Profile
Sign off page:
This section of the credit note contains the basic information about the client like the name of
the client, the industry in which they are operating, rating of the borrower, KYC details, CAM
date and CAM review date etc.
This section also has the details of facility summary. It is important because RBI mandates
limits to lending for a single borrower and for an entire group.
Executive Summary
An Executive Summary gives a snapshot of everything that is important and critical to the credit
decision.
Facility Description
This section details all the terms and conditions of the facility. The facility letter also contains
the details of Covenants and Documentation.
Covenants: The covenants are classified into financial and non-financial (general)
covenants.
Documentation: Documentation is suggested on basis of the security and structure of
the facility granted. Some documents are standard. For example:
o Loan Agreement
o DPN
o Letter of Continuity
o Counter indemnity for BG limit
o Indemnity for Letter of credit etc.
Borrower profile
The Business Profile – Part 1: Elements in the business profile include:

1. Basic Details of the Borrower
2. Ownership Pattern
3. Board of Directors
4. Management Evaluation
5. Capital Market Data
6. Current Banking Facilities
7. External Ratings Available
8. Sales Segment Profile
9. Production Facilities/Offices
10. Production Analysis
11. Foreign Currency Exposure
12. Subsidiary Company: This is critical for companies, where there is a big difference
between the standalone financials and the consolidated financials.
Basic data that needs to be covered in this section -
i. Snapshot of subsidiary financials
ii. Loans/ICD (Inter Corporate Deposits) between company and subsidiaries
13. Company History and Background: The company history and background is similar
to the section already included in the executive summary, but has to be written in more
detail here.
14. Future Plans
The Financial Profile

The data from the balance sheet and profit & loss statement is input into a spreadsheet in a
standard format acceptable to the bank. It includes:
Financial Summary – P&L and Balance Sheet: The 4 basic sections to analyze are:
Turnover
Liquidity
Profitability
Financial Soundness
Cash Flow Statement: One needs to look at net cash from -

Operations
Investing activities and
Financial activities
Summary of Current Performance: The rating of the company always happens on the basis of
historical financials. There is also a set of unaudited results that are released every quarter.
These are publicly available on the NSE/BSE website.
Contingent Liabilities: Contingent liabilities are off-balance sheet items, but can have a material
impact on the company.
Projections of Financials: There are different scenarios that have to be considered in this
section. Hence, this section requires extensive help from the company itself.
Comparison of Firms within the Industry: This is done with a basic snapshot of financials and
capacity.
The Business Profile – Part 2

This includes:
Key Credit Strengths
Key Credit Risks (KCR) and Mitigates
Project/Structured Risk Evaluation
Assessment of Facilities Offered
Rationale of Facility
Ways-out Analysis: This gives the alternative means by which the company can pay back
the bank.
Industry Outlook: It looks at the industry features and cycles.

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Corporate Banking - Credit Analysis

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Introduction to Credit Risk Management

Credit Team Structure

Credit Appraisal – Large Corporates vs. Mid Corporates & SMEs

Parameters Large Corporates Mid Corporates and SMEs

The Basic Credit Risk Model

vi. Average net profit margin of players

4. Industry Competitors - Rivalry among existing firms in the industry

2. Promoter and Management Track Record

4. Operational Profile - In the operational profile, you will have to analyze:

Value chain strengths

Cost structure and control

Peer Group Analysis

Financial Analysis: Profit & Loss Statement

Other Operating Income –

Purchase of Other Finished Goods

Depreciation & Amortization:

Hence, the formula for Cost of Production is:

Cost of Sales (COS)

2. Operational Lease Payments – is the cost incurred on any machinery/equipment leased

Operating Profit before Tax

Interest expense refers to interest paid by company on loan taken/debentures issued.

PBT Before Exceptional Items

Non-Operating or other Income

Profit Before Tax (PBT)

Lenders do not consider Exceptional or Extraordinary Items, as they are:

Example for Extra-ordinary Income: Cash

Example for Extra-ordinary Income: Non Cash

Example for Extra-ordinary Expense: Cash

Example for Extra-ordinary Expense: Non Cash

Profit After Tax (PAT)

Financial Analysis: Balance Sheet

2. Other Current Liabilities – It includes -

Capital and Surplus

Minority Interest – It refers to the shareholding of external shareholders in a company’s

Current Assets include -

Inventory can be further broken into –

Trade debtors are further classified from a credit perspective into:

3. Other Current Assets - It includes:

Non Current Assets

Deferred Tax Asset

Intangible Assets/Miscellaneous Expenditure

Short Term Loans

Reclassified Balance Sheet

Capital & Reserves (c) Other Non Current Assets (g)

Total Liabilities (a+b+c+d) Total Assets (e+f+g+h+i)

PBDIT Margin - PBDIT/Operating income.

ROCE – PBIT/Average Capital Employed

Return on Equity (ROE) - Earnings after tax/Capital and Reserves

Basic Earning Power - PBIT/Total Assets

Interest Coverage Ratio - (PAT+Interest Exp.+Depreciation)/Interest expense.

(PAT+Interest Expenses)/Interest Expenses - This is similar to interest coverage, but

Current Ratio - Total current assets/Total current liabilities

WIP Holding (in days) – (Stock in process/Cost of goods sold)*365

FG Holding (in days) – (Finished goods/cost of goods sold)*365

Receivables Holding (in days) – (Total debtors/Total operating income)*365

Credit Availment/Days Payable (in days) – [Creditors for purchases/(Purchases finished

Operating Cycle in Days - RM holding + WIP holding + Receivables holding + FG holding -

Working Capital Assessment

MPBF stands for Maximum Permissible Bank Finance.

Calculation of MPBF: Method I

Step 1: Calculation of WCG: TCA- OCL

Step 2: Calculation of SNWC: 25% of WCG